Many cottagers hope their cottage remains in the family after they’re gone. Having a plan in place to transfer the ownership to their children is key.
Transferring a cottage to your children can create an unexpected income tax burden so let’s consider options that will help the process.
Use a personal trust
Transferring your cottage to an inter-vivos trust, which is a trust created while you are still living, can allow you to gift ownership of your cottage to your children as beneficiaries of the trust. As well, an inter-vivos trust will allow you to enjoy the continued use of the cottage. Aside from tax planning, a significant benefit of holding a cottage in an inter-vivos trust is that probate fees can be avoided on death.
If you transfer the cottage to an inter-vivos family trust, there will be a deemed disposition at fair market value at that time. If their cottage increased in value from the time they purchased it, there likely will be a taxable capital gain realized on this transfer. However, you may be able to shelter a portion of this gain from income tax by using their principal residence exemption.
Consider the 2016 changes to the principal residence exemption
Legislative changes made in 2016, which were designed to close loopholes surrounding the use of the principal residence exemption, could impact your decision on whether to transfer the cottage to a trust. As a result of these changes, if the cottage is subsequently sold by the trust, there will be a disposition for income tax purposes and taxes will become payable.
Should you consider a joint spousal trust?
If you are older than 65, you are able to transfer the ownership of their cottage to a joint spousal trust without triggering the application of the deemed disposition rules discussed above.
When the last of either you or your spouse dies, your children will be transferred ownership of the cottage and there will be a deemed disposition of the cottage at that time. The trust will then pay tax on any increase in value over the cottage’s adjusted cost base (ACB).
What about a testamentary trust?
When the first spouse dies, the cottage can be transferred directly to the surviving spouse (or to a testamentary spousal trust) on a tax-free basis. When the surviving spouse dies, the cottage will be deemed to be disposed of at fair market value and their estate (or the spousal trust) will pay tax on the accrued gain. Should there be a taxable gain, the principal residence exemption may be used to shelter all or a portion of that gain, if available. After death, the cottage will be an asset of the testamentary trust, with the couple’s children as beneficiaries.
Joint tenancy with the right of survivorship
Another option to consider is transferring ownership of the cottage directly to your children during their lifetime. One can accomplish this by transferring title into joint ownership with the right of survivorship. When one owner dies, the cottage simply transfers into the hands of the other joint owner(s), thereby potentially bypassing the estate and thus avoiding probate.
There may be future implications to claiming the principal residence exemption when this option is used.
Sell the cottage to the children
You can also sell the cottage to your children while they’re still alive. The capital gain will be calculated based on the fair market value of the property regardless of the selling price since the sale is considered to take place between non-arm’s length parties. If you sell the cottage to your children for less than fair market value, you will still pay tax as though you received fair market value and their children will have an ACB equal to the amount they paid, possibly resulting in double taxation.
BDO can help you understand your options
There are many options for keeping a cottage in the family for future generations to enjoy. While not always easy, considering both the emotional and financial aspects of transferring or gifting a cottage to your children or family members will go a long way to ensuring a smooth transition.
If you own a cottage, or a vacation property, please speak to me if you’re thinking about transitioning your cottage or vacation property to your children or family members.
Scott Conner is an experienced tax practitioner and practical problem solver at BDO. As a partner specializing in Canadian income tax, Scott has particular specialties in private companies, planning for estates, trusts, and complex transactions. As personal tax season approaches, Scott and his team understand personal taxes are as individual as clients themselves. BDO works closely with their clients to understand their specific needs and adjust strategies accordingly. BDO partners and staff take a proactive, hands-on approach. They closely follow existing and proposed legislation to determine how it will affect individual financial goals, and provide ongoing guidance.